Note: I will not be grading answers but your thought process to see how you combine everything we have learned so far in this course to come up with an estimate of the stock's fair value. Please organize your solution with MS Excel

Case Study $1$: Firm$/$Equity Valuation $(15$ points$)$

Assume it's the beginning of $2024$ and you recently got your first job as an Equity Analyst at the money management fund: Bison Capital Management LLC$,$ whose objective is to buy stocks that are undervalued. Your boss, Mr$.$ Howard Peters, the fund's star portfolio manager lately has been researching a company called Kappa Inc., a fintech firm. He believes Kappa's stock will be a good buy and has tasked you to figure out if Kappa Inc.$\text{'}$s stock is undervalued.

Based on Kappa's financial statements, Mr$.$ Peters has estimated the weighted average cost of capital $($WACC$)$ of Kappa to be $\backslash (9\mathrm{.}00\backslash \%\backslash ).$

Using that as the discount rate, he would like to know the following:

$1.$ What should be the Firm Value of Kappa Inc. $($Fair value of the entire firm$)?$

$2.$ What should Kappa Inc.$\text{'}$s stock price be and is it undervalued or overvalued?

Preliminary analysis shows that Kappa Inc. pays no dividends currently $($i$.$e$.,$ has a retention ratio of $\backslash (100\backslash \%)\backslash ).$ It is expected to grow at a high rate over the next five years after which it is expected to settle to a sustainable growth rate of $\backslash (3\backslash \%\backslash )$ indefinitely.

Kappa Inc.$\text{'}$s recent income statement and balance sheets for the last $2$ years show the following:

$\backslash$begin$\{$tabular$\}\{|$c$|$c$|$c$|$c$|$c$|$c$|\}$

$\backslash$hline $\backslash$multicolumn$\{6\}\{|$c$|\}\{$Kappa Inc. $-$ Balance Sheet $($in Millions of U$.$S$.$ Dollars$)\}\backslash \backslash$

$\backslash$hline & $\backslash$multicolumn$\{2\}\{|$c$|\}\{$Assets$\}$ & $\backslash$multicolumn$\{3\}\{|$l$|\}\{$Liability and Owners Equity$\}\backslash \backslash$

$\backslash$hline & $31$ Dec. $2022$ & $31$ Dec. $2023$ & & $31$ Dec. $2022$ & $31$ Dec. $2023\backslash \backslash$

$\backslash$hline $\backslash$multicolumn$\{6\}\{|$l$|\}\{$Current Assets$\}\backslash \backslash$

$\backslash$hline Cash and Equivalents & $\backslash$$$210$ & $\backslash$$$248$ & Total Current Liabilities & $\backslash$$$671$ & $\backslash$$$726\backslash \backslash$

$\backslash$hline Accounts Receivable & $474$ & $513$ & & & $\backslash \backslash$

$\backslash$hline Inventory & $\backslash (\backslash$underline$\{520\}\backslash )$ & $564$ & $\backslash$begin$\{$tabular$\}\{$l$\}$

Long term debt $-$ Bonds: $\backslash \backslash$

$12\mathrm{.}4\backslash \%$ Annual Coupon, $\backslash \backslash$

$5$ years to maturity,

ytm $=5\backslash \%$

$\backslash$end$\{$tabular$\}$ & $1,010$ & $1,050\backslash \backslash$

$\backslash$hline Total Current Assets & $1,204$ & $1,325$ & & & $\backslash \backslash$

$\backslash$hline & & & Common Stock $($par $\backslash$$$25$ per share$)$ & $1,420$ & $1,585\backslash \backslash$

$\backslash$hline Gross Fixed Assets & $2,501$ & $2,850$ & & & $\backslash \backslash$

$\backslash$hline

$\backslash$end$\{$tabular$\}$

Mr$.$ Peters gathered the following relevant stock information to calculate the WACC $($We will cover in a subsequent chapter how to estimate WACC. For now, it's been calculated for you$)$:

$-$ Current stock price: $\backslash (\backslash$$ $90\backslash )$

$-$ Stock's Beta $\backslash (=1\mathrm{.}2\backslash )$

$-$ Risk free rate is $\backslash (3\backslash \%\backslash )$

$-$ Market Risk Premium is $\backslash (6\backslash \%\backslash )$

$-$ Marginal tax rate is $\backslash (21\backslash \%\backslash )$

Since your boss will be travelling overseas and will not have time to meet with you to discuss your valuation, he would like you to use the following steps to ease his understanding of your work $($to receive any credit please show your work$)$: Use the following Steps:

$1.$ Calculate the expected high growth rate for the first $5$ years.

$($Note: ROE $=$ net income$/$Book Value of Common Equity$)$

$2.$ Find the Firm's Initial FCF i$.$e$.,$ FCFF at the end of $2023/$beginning of $2024($FCFF $\backslash (\{\}^\{0\}\backslash )).$

$3.$ Now that you have FCFFo, estimate the future cash flows and find the fair value of the firm.

$4.$ What should be the market value of the entire firm's equity if the market value of the firm's debt is $\backslash (\backslash$$ $1,386\mathrm{.}40\backslash )$ million?

$5.$ What should be the price per share if there are $63\mathrm{.}4$ million shares outstanding $($Note: Shares outstanding $=$ BV Common Equity$/\backslash$$$25$ par per share$)?$

$6.$ Is the stock price undervalued or overvalued?